Summary

New reports point to significant disruption in traditional sectors such as the vehicle and energy industries.

Electric Vehicles (EV) and adoption of Autonomous Driving seen leading the disruption.

Bold prediction regarding the potential for disruption is depressing sentiment and valuations for traditional companies in these sectors.

In the first of three articles, we assess whether the negative sentiment towards these sectors is warranted and whether it is providing a contrarian investment opportunity.

The rise of electric vehicles (EVs) and predictions that they will come to dominate in the next decade is a narrative emerging as a key long-term headwind for investors in traditional companies in the vehicle and energy industries. This article is the first in a series of three articles where we consider these predictions and assess whether the negative sentiment towards these sectors assumed to be most negatively impacted, may in fact provide a contrarian investment opportunity. For value conscious investors, favourable risk vs. reward opportunities often arise precisely when sentiment towards any specific industry or asset class is depressed.

Two leading 'thought leaders' on clean energy are Tony Seba and James Ariba. In their recent report entitled "Rethinking Transportation 2020-2030," they further make the bold prediction that EVs will displace traditional internal combustion engine or "ICE" vehicles. They also contend that the widespread adoption of autonomous driving vehicles (AVs) and Transport as a Service (TaaS) will disrupt and partially displace the traditional vehicle industry.

Some of the startling predictions being made in this report include the following:

95% of US passenger miles traveled will be served by on-demand AVs owned by fleets not individuals or TaaS providers such as Uber (UBER) by 2030.

Total passenger miles will grow from 4trn to 6trn. These TaaS vehicle fleets will almost entirely consist of EVs.

In 2030, traditional ICE vehicles will still represent 40% of the total US vehicle fleet, but will provide just 5% of total passenger miles. The prediction is based on TaaS services being significantly more economical for consumers than owning their own vehicle.

The report forecasts annual savings of $5,600 per household. 10x higher utilization rates per AV and longer vehicle mile lifetimes implies that far fewer vehicles will be required to service the same number of annual passenger miles.

As a result, annual vehicle sales will collapse, declining by as much as 70%. Oil demand will peak at 100mn barrels per day (bpd) in 2020 and decline to 70mn bpd by 2030, leading to an inevitable collapse in oil prices of $25 per barrel.

In this article, we will consider these bold predictions carefully and assess how rational or accurate they may prove to be. Let's not forget that similar bold predictions about emerging technologies have been made before and not necessarily playing out exactly how the prognosticators envisaged. One example would be the 'Segway'. The following article neatly sums up why the Segway failed to meet the lofty expectations that accompanied its launch in 2001. The reason was mainly social, not technological. The Segway was ultimately not that practical in many instances, something overlooked by its early cheerleaders. Could TaaS face a similar future?

Our view is that although TaaS will ultimately prove to be more successful than the Segway, the bold prediction that on-demand fleet owned vehicles will come to dominate 95% of total passenger miles traveled each year, will likely also prove far too optimistic. TaaS will possibly work well in dense urban city areas and come to replace the traditional taxi industry and meaningfully erode the market share of car rental companies.

The greatest threat posed by TaaS, however, may be directed towards public transportation. In major cities such as New York or London, if TaaS becomes very economical, it may end up displacing a large portion of the market served by public buses and underground subways. It will be interesting to see what the authorities in these cities would make of such a development. It is possible that in some countries TaaS providers could end up being heavily taxed or even banned outright (as Uber has already been in certain jurisdictions).

However, the TaaS as a viable model may break down in certain instances and below we outline a number of examples:

Waiting times for a vehicle or ride in suburban and rural areas may be far too inconvenient for many potential users.

In certain use cases, using a fleet-owned AV will also be far too inconvenient. What does a young mother do with her baby seat at her destination?

If TaaS providers increase the number of vehicles in their fleet in order to reduce waiting times in less densely populated areas, would the service still be economical? As an example, the number of rides per day that a typical fleet-owned AV may be able to deliver would be far less in suburban and rural areas than in densely populated urban areas.

Many households will take longer trips or weekend country road trips that fleet-owned AVs will not be able to conveniently service. If vehicles have the ability to seamlessly switch between automated and piloted modes, owning a vehicle will remain very attractive for most users. This is especially true of circumstances where the personal preference is to retain some freedom, flexibility and autonomy.

In this sense, many or most suburban and rural households will continue to own their own vehicle.

The authors of the report do not account for the extreme peak and trough in passenger miles traveled in a 24-hour cycle. If we assume that some 80mn Americans commute to work and back home every day from suburban areas at roughly the same time, this would imply that on-demand TaaS providers would need to have 80mn vehicles available for a few hours a day and then the rest of the day they would require far less. What would this do to the economics of such a service?

The report suggests that some 26mn fleet-owned AVs will be able to deliver a total of 5.7trn passenger miles per year or 15.6bn passenger miles per day. This amounts to 25 miles per hour per vehicle. Essentially, the authors are assuming near continuous use of all fleet-owned AV vehicles. When accounting for the daily fluctuation between peak and off-peak demand and the servicing of less densely populated areas, this is an almost impossible assumption to make. The report assumes that fleet-owned AVs will almost immediately be able to pick up a new passenger near the drop-off location.

In the most optimistic scenarios for TaaS, we could perhaps presume that all urban and inner-suburban households may adopt the service and forgo personal vehicle ownership. If an area with a household density of more than 1500 per square mile is considered sufficiently dense to support a TaaS business model, some 35% of all families would possibly forgo personal vehicle ownership. This is based on the below data taken from the Census Bureau which would equate to roughly 50mn houses based on a projection for 140mn households in 2030.

It is very doubtful that the vehicle ownership ratio for the remaining suburban and rural households will decline from current levels of around 2 (in fact currently closer to 2.4). On these assumptions, we can project that some 90mn households will still retain personal ownership of around 180mn vehicles by 2030. An efficient fleet-owned AV service would then perhaps comprise about 10mn vehicles, down from the 26mn projected if such fleets were to service 95% of all passenger miles for these more urban households. This implies that the total vehicle fleet would decline to around 190mn from 240mn at present, excluding all commercial vehicles.

This is still quite a negative outlook for the traditional vehicle industry, but it should be remembered that this scenario assumes 'zero' vehicle ownership for urban or inner suburban households. If just half of these households were to choose to own at least 1 vehicle for longer trips and weekend drives, the total vehicle fleet would rise to 215mn, not far from the current level.

Annual US new vehicle sales as a % of the total vehicle stock presently stands at around 7%. Based on a reduced total vehicle fleet of around 200mn, total annual sales will still amount to roughly 14mn per year, only a modest decline from the current 17mn.

In summary, if our more sanguine expectations for TaaS prove to be accurate, what would the implications be for the various industries cited as being negatively impacted by the widespread adoption of TaaS?

Traditional vehicle manufacturers

It will not prove that disruptive or disastrous for existing vehicle manufacturers, although vehicle sales even under our assumptions, could well stagnate for a protracted period of time. There is also nothing stopping existing vehicle manufacturers from launching their own TaaS initiatives in conjunction with or in a JV with Silicon Valley tech firms currently developing this technology. Do these tech firms really want to be responsible for running huge fleets of vehicles, when it would be much easier to just earn a royalty on the use of their technology or components?

The JV between Mobileye (NASDAQ:INTC) and BMW (OTCPK:BMWYY) perhaps already hints at the evolution of this type of business model in the future. In fact, despite the perception that the traditional motor vehicle manufacturers are laggards when it comes to AV technology, a recent data dump from the California DMV suggests otherwise.

The table below shows AV miles driven per disengagement, or in other words, the miles driven before the "autopilot" function had to be disengaged. As the data shows, Google/Waymo (NASDAQ:GOOG) (NASDAQ:GOOGL) appears to be far ahead of everyone, but traditional vehicle companies such as Ford (NYSE:F) and BMW seem to be advancing quite well, at least based on the data below.

The data compiled above by Raymond James does come with the following caveat -

Nevertheless, the suggestion that traditional vehicle companies are not even on the "playing field" when it comes to AV technology, appears patently untrue.

Secondly, Fleet maintenance requirements for parts, etc., suggest that they may be best placed to offer such a service economically from a vertically integrated standpoint. Secondly, the rise of the 'connected car' will generate additional revenue streams for traditional vehicle makers by offering internet connectivity and ancillary related services that could replace any potential loss of existing revenues.

Finally, current valuations for vehicle makers such as Ford and GM (NYSE:GM) are already inexpensive and perhaps at least partially discounting the worse-case scenario. For companies such as Apple (NASDAQ:AAPL) and Google, which sit with very large cash piles, it may even make sense to consider buying a Ford or GM. If we consider the fact that Tesla (NASDAQ:TSLA) has spent nearly $9bn in capital expenditures to attain a production target of 500,000 vehicles per year, it may be a bargain to buy GM for $50bn for its annual production capacity of 10mn vehicles per year.

Vehicle insurance

A future dominated by fleet-owned AVs would negate the need for any form of motor insurance since the assumption is that the potential for human error would be reduced to zero. However, even under this scenario, TaaS fleet owners are still likely to be required to buy third-party insurance. For instance, what happens if a pedestrian accidentally runs in front of an AV? Can the AV predict and avoid such an accident?

Most importantly, the assumption that motor insurance will no longer be required is based on the assumption that all vehicles will be autonomous or self-driving. If we are correct and a large % of the population still ends up owning at least one car, then there will still be a need for insurance and third-party insurance for the TaaS fleet owners. Outlawing the freedom to drive your own car will undoubtedly lead to massive pushback from many quarters of civil society.

Disclosure:I am/we are long F, GM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.